California Supreme Court Rights the “Occurrence” Ship: Unintended Harm Resulting from Intentional Conduct Triggers Coverage Under Liability Insurance Policy

Scott S. Thomas | Payne & Fears | June 6, 2018

SUMMARY

In a ruling that bodes well for policyholders, the California Supreme Court provides much-needed clarity on the question of when a so-called “intentional act” may give rise to insurance coverage under a liability insurance policy. In Liberty Surplus Insurance Corp. v. Ledesma & Meyer Construction Co., Case No. S23765 (Cal. June 4, 2018), the Court holds that an employer’s potential liability for negligent hiring, after its employee allegedly abused a 13-year old student, is the result of an “occurrence” and is thus covered under the employer’s liability insurance policy.

COURT OPINION

The court’s opinion dispels the misguided notion that an intentional act resulting in unintended harm is never an “occurrence” and can never trigger coverage. What matters, according to the Court, is that, from the insured’s point of view, the consequences of its conduct are “unexpected, unforeseen, or undesigned” – even if the conduct is intentional. And in a concurring opinion, Justice Liu rightfully questions the legitimacy of the notion that intentional conduct cannot trigger coverage, even when it produces an unintended result, unless, in the words of a 1989 appellate court decision, some “additional, unexpected, independent, and unforeseen happening occurs that produces the damage.” As Justice Liu explains, this intervening “happening” may be something as simple as the insured’s mistaken belief that he was acting in self-defense, or that the victim had consented to the insured’s conduct. This much-needed clarification restores vitality to the fundamental principle that injuries are “accidental” when they are “unexpected, unforeseen, or undesigned,” regardless of their cause.

KEY TAKEAWAYS

This ruling will apply in many contexts: For example, contractors who “intentionally” build things; competitors who “intentionally” disparage another’s product; employers who “intentionally” hire employees who do bad things. The Court’s decision restores the law’s fidelity to fundamental principles enunciated in the seminal California “occurrence” case: Gray v. Zurich, 65 Cal. 2d 263 (1966). And it ought to dampen insurers’ enthusiasm for denying claims on the spurious ground that the insured’s conduct – even though it resulted in bodily injury or property damage that the insured did not expect or intend to cause – was “intentional.”

The Tenth Circuit’s Prediction: New York State Likely to Follow Trend Recognizing Damages Caused by Subcontractor’s Faulty Work is a Covered “Occurrence”

By Frederic J. Giordano and Stephanie S. Gomez | K&L Gates | May 17, 2018

The United States Court of Appeals, Tenth Circuit recently issued a favorable decision for policyholders finding property damage arising from a subcontractor’s faulty work arose from an accidental “occurrence” under New York law.  In Black & Veatch Corp. v. Aspen Ins. (UK) Ltd,[1] a 2–1 Tenth Circuit panel agreed with Black & Veatch Corp. (“B&V”) that its excess policy — which contained a New York choice-of-law provision — covered claims for property damage to a third party caused by its subcontractor’s faulty work.[2]  The Tenth Circuit reversed the district court’s ruling that B&V’s subcontractor’s faulty work caused damage to only B&V’s own work and, therefore, was not a covered “occurrence.”[3]  The Tenth Circuit concluded the New York Court of Appeals would likely find the subcontractor’s faulty work was an accidental “occurrence,” following the growing trend of other state high courts that have addressed this coverage issue under commercial general liability (“CGL”) polices.[4]  Policyholders — whose policies are governed by New York law — should take notice and consider the implications of this decision on whether New York will soon join the majority view that faulty workmanship by a subcontractor can be an occurrence under CGL policies.

In 2005, B&V, a Kansas engineering firm, entered into contracts with American Electrical Power Service Corporation (“AEP”) to engineer several jet bubbling reactors (“JBRs”) — which eliminate contaminants from the exhaust emitted by coal-fueled power plants — at four coal-fire power plants in Ohio and Indiana.[5]  B&V subcontracted the work for the JBRs’ internal components.[6]  Deficiencies in the subcontractor’s work caused the JBRs’ internal components to deform, crack, and sometimes collapse.[7]  Subsequently, AEP notified B&V of the damaged JBRs arising from its subcontractor’s faulty work.[8]  AEP and B&V settled the dispute, and B&V agreed to pay more than $225 million in repair and replacement costs for its subcontractor’s defective internal components.[9]

After recovering $3.5 million from its primary insurer, B&V submitted coverage claims to Aspen Insurance Ltd. (“Aspen”) under its excess CGL policy (the “Policy”), which provided $25 million of limits per occurrence.[10]  Aspen denied coverage on the grounds that damage arising from and confined to B&V’s own work was not an “occurrence.”[11]  In 2012, B&V filed suit against Aspen in the U.S. District Court for the District of Kansas for breach of contract and declaratory judgment as to B&V’s rights under the Policy.[12]  Aspen cross-moved for partial summary judgment on the coverage issue.[13]  The district court granted Aspen’s motion, holding property damage arising from the construction defects were not covered “occurrences” under the Policy because only B&V’s own work product — the JBRs — was damaged by its subcontractor’s faulty workmanship.[14]  B&V appealed.[15]

The issue before the Tenth Circuit was whether the New York Court of Appeals would find that the Policy covers a portion of B&V’s payments to AEP to repair and replace the damaged JBRs.[16]  The Tenth Circuit predicted the Court of Appeals would decide that the damages to the JBRs constitute an “occurrence” that triggers coverage under the Policy and, therefore, vacated the district court’s summary judgment decision.[17]  The Tenth Circuit’s reasoning was based on, but not limited to, the Policy’s language, New York’s rule against surplusage, and the trend among state supreme courts.[18]

First, the Tenth Circuit held the subcontractor’s shoddy work constituted an “occurrence,” as that term is defined in the Policy, because it was accidental and harmed a third party’s property.  The Tenth Circuit considered the Policy’s (1) basic insuring agreement defining the general scope of coverage and key terms, (2) exclusions from coverage, and (3) exceptions to the exclusions.[19]  The Policy’s basic insuring agreement held that Aspen would pay on behalf of B&V sums in excess of the liability limit provided by other insurance policies which B&V would “become legally obligated to pay as damages for . . . ‘Bodily Injury’ or ‘Property Damage’ . . . caused by an ‘Occurrence.’”[20]  An “Occurrence” was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions, that resulted in ‘Bodily Injury’ or ‘Property Damage’ that was not expected or not intended by the ‘Insured’.”[21]  “Property Damage” was defined as “physical injury to tangible property of a ‘Third Party’, including all resulting loss of use of that property of a ‘Third Party’ . . . .”[22]  The Policy also defined “Third Party” as “any company, entity, or human being other than an ‘Insured’ or other than a subsidiary, owned or controlled company or entity of an ‘Insured’.”[23]

The Tenth Circuit concluded the Policy covers damages arising from an “occurrence,” which includes an accident causing damage to the property of a third party — even though the term “accident” is not defined under the Policy.[24]  The Tenth Circuit reasoned B&V did not intend or expect its subcontractor to damage the JBRs.[25]  Because the JBRs’ construction defects were unintentional, they constituted an accidental “occurrence.”[26]  Next, the Tenth Circuit considered Aspen’s argument that damage to a third party did not occur since the Policy designated AEP as an additional insured, and the JBRs belonged to AEP.[27]  Disagreeing, the Court found that “when AEP claimed damages against B&V, the separation of insureds clause rendered AEP a third party with respect to its claims for property damage against B&V.”[28]  Thus, the damages involved physical harm to the property of a third party.

In further support of the ruling that it is a covered “occurrence,” the Tenth Circuit noted that Aspen’s interpretation of “occurrence” would render several Policy provisions “surplusage,” in violation of New York general principles of contract interpretation.[29]  The Policy included a “Your Work” exclusion that prohibited coverage for property damage to B&V’s own completed work.[30]  The “subcontractor exception” to the “Your Work” exclusion, however, provided that the exclusion did not apply “if the damaged work or the work out of which the damage arises was performed on [B&V’s] behalf by a subcontractor.”[31]  The Policy further contained “Endorsement 4,” which excluded coverage for property damage to “that particular part of real property” on which B&V or its subcontractor were actively working.[32]

Aspen’s interpretation of “occurrence” excluded accidental damage to B&V’s own work resulting from a subcontractor’s faulty workmanship.[33]  The Tenth Circuit found that the Policy’s “Your Work” exclusion and “subcontractor exception” would lose their meaning under Aspen’s definition of “occurrence” because “it would be redundant to say the Policy does not cover property damage to B&V’s own work (as stated in the ‘Your Work’ exclusion) if the definition of ‘occurrence’ categorically and preemptively precludes coverage for such damages in the first instance.”[34]  The Tenth Circuit further explained “there would there would be no reason for the Policy to state that it covers damages to [B&V]’s work when ‘the damaged work . . . was performed . . . by a subcontractor’ if the basic insuring agreement does not encompass these damages.”[35]  The Tenth Circuit further held Aspen’s interpretation of an “occurrence” would also render part of “Endorsement 4” meaningless if faulty workmanship resulting in damage to B&V’s own work could never trigger coverage as an “occurrence.”[36]  In essence, if the Policy could never cover damage to the B&V’s work in the first instance, then there would be no reason for “Endorsement 4” to exclude coverage only for damage to a “particular part” of the JBRs.[37]

General contractors should take note of the Tenth Circuit’s policyholder-friendly decision in Black & Veatch Corp., which provides guidance to insureds with policies governed by New York law.  Although New York’s highest court has not addressed whether construction defects caused by a subcontractor’s defective work constitutes a covered “occurrence” under CGL polices, the Tenth Circuit came to a significant conclusion while interpreting New York law.  Policyholders should keep an eye on whether New York “joins the clear trend” among other states’ interpretation of CGL coverage.

 

Notes

[1] 882 F.3d 952 (10th Cir. 2018).

[2] Id. at 971.

[3] Id. at 957.

[4] Id. at 971.

[5] Id. at 954.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id. at 955–56.

[11] Id. at 956.

[12] Id.

[13] Id.

[14] Id.

[15] Id.

[16] Id.

[17] Id. at 956–57.

[18] Id. at 956–57, 962.

[19] Id. at 958.

[20] Id. at 955.

[21] Id.

[22] Id.

[23] Id.

[24] Id. at 965.

[25] Id. at 962–63.

[26] Id.

[27] Id. at 963.

[28] Id. at 964.

[29] Id.

[30] Id. at 955.

[31] Id. at 956.

[32] Id. at 955 (emphasis in the original).

[33] Id. at 964.

[34] Id.

[35] Id.

[36] Id. at 965.

[37] Id.

Faulty Workmanship, Even if Charged as Negligence, Isn’t Fortuitous Enough to Be an “Occurrence” Under Liability Policy

Richard Wolf | Claims Journal | April 16, 2018

Every once in a while, a court teaches us by judicial decision an entire chapter of insurance law lessons we can carry with us, secure in the knowledge that we can reason our way to the right result in insurance coverage disputes. Such a court opinion was filed March 30, 2018 by the US District Court for the Eastern District of Pennsylvania, applying Pennsylvania law. The case is State Farm Fire & Cas. Co. v. DTL Mechanical. It is reported at 2018 U.S. Dist. LEXIS 54953. It reminds us that commercial liability insurance is typically limited to defending against, or paying, damages from lawsuits against policyholders for property damage, bodily injury or personal and advertising injury, caused by an “occurrence”— an accident.

The facts of this State Farm case were certainly not unusual – which makes its teachings so useful, especially in resolving insurance coverage issues typically encountered in construction projects. Scott and Maria Evans engaged Bianco Contractors, Inc. (Bianco) to build an addition to their residence. Bianco, in turn, subcontracted with DTL Mechanical, LLC (DTL) to install a heating, ventilation and air conditioning (HVAC) system in the home addition. Numerous problems plagued the project, including the HVAC system, forcing the Evanses to replace what they alleged was a defectively designed and installed HVAC system. The property owners brought suit against Bianco in Pennsylvania state court, and Bianco sued DTL, alleging that the HVAC subcontractor was at fault in installing an improperly designed, sized and vented new HVAC system.

Bianco contended in the owners’ lawsuit that under the subcontract, DTL had assumed responsibility for installing a new HVAC system in the Evanses’ addition. The Evanses alleged that DTL’s work had failed to comply with pertinent building codes and DTL had breached implied warranties that the new HVAC system would comply with industry standards and be fit for ordinary usage. Bianco contended that the damages sustained by the Evanses were caused by DTL’s negligent performance of its installation work.

During the construction work, DTL was insured by a State Farm Business Owners liability insurance policy providing that State Farm would pay those sums Bianco became legally obligated to pay as damages because of bodily injury, property damage or personal and advertising injury caused by an “occurrence,” which the policy defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” (Emphasis added.)

The policy defined “property damage” as meaning “[p]hysical injury to tangible property, including all resulting loss of use of that property,” or “[l]oss of use of tangible property that is not physically injured or destroyed, provided such loss of use is caused by physical injury to or destruction of other tangible property.”

State Farm refused to defend or indemnify DTL in the state court lawsuit, because, the insurer said, the HVAC installation work, alleged by the Evanses and Bianco to have been negligently performed by DTL, did not constitute an “occurrence,” as defined by the policy.

Eventually, the Evanses, Bianco and DTL settled the state court litigation, with DTL assigning to the Evanses all of DTL’s rights of action under the State Farm liability policy based on the subcontractor’s right to a defense and/or indemnification, and any bad faith claims arising from State Farm’s refusal to indemnify and/or defend DTL in that lawsuit.

Still later State Farm brought suit in federal court against DTL and the Evanses for declaratory relief (the basis of federal court jurisdiction is unclear) and then moved for a summary judgment declaring that it did not owe DTL a defense or indemnification in the homeowners’ litigation against Bianco and DTL.

Procedurally, the court said, a summary judgment should be granted to State Farm if there is no genuine issue of material fact separating the parties, and, viewing the facts most favorably to the other parties, State Farm is entitled to judgment as a matter of law. A genuine issue of material fact exists if a reasonable jury could return a verdict for the nonmoving parties.

The homeowners asked the court to determine that they were entitled to recover as damages the cost of defending and indemnifying DTL for damages based on State Farm’s legal duties as a liability insurer for DTL in the litigation commenced by the Evanses. The court recited the general rule that the duty of a liability policy insurer to defend its policyholder is broader than the duty to indemnify it (see, e.g., California Practice Guide: Insurance Litigation (2016 Update), ¶ 7:501), so it necessarily follows that the insurer will not have a duty to indemnify its insured for a judgment in an action for which it was not required to provide it with a defense.

Accordingly, a typical first step in analyzing coverage is to assess whether the insurer has a duty to defend its policyholder. This is done by comparing the charging allegations of the complaint against the insured to the terms of the grant of coverage found in the policy of insurance. In this process, factual allegations of the complaint are taken as true and liberally construed in favor of the insured. The duty to defend is present if the allegations of the complaint could potentially fall within the coverage wording of the policy. In evaluating the policy duty to defend, the court must focus on factual allegations in the complaint, not the causes of action against the policyholder. In order to determine whether the duty to defend is triggered, the court held, a court must first examine the language of the insurance policy to determine the scope of coverage. Next, the court must analyze the complaint against the policyholder to determine if the claims asserted by the plaintiff potentially fall within the scope of the policy’s coverage.

The court concerned itself with a discussion of whether property damage caused by faulty workmanship qualifies as an “occurrence,” defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The court, citing a decision of the Supreme Court of Pennsylvania, agreed that property damage caused by faulty workmanship is not an “occurrence”, because an “accident” requires a degree of fortuity not covered by faulty workmanship. Relying on the same case, the court in the new decision said that this type of policy does not cover “contractual liability of the insured because the product or completed work is not that for which the damaged person bargained.” Accordingly, an insurer has no duty to defend an insured against a lawsuit alleging only “property damage” resulting from poor workmanship. And this is true, moreover, even when faulty workmanship is cast as a negligence claim, is based upon a failure to follow industry standards or is couched as a breach of warranty.

Another coverage touchstone regarding liability insurance coverage analysis is that damages that are a reasonably foreseeable result of faulty workmanship are not covered. Put another way in the new case, there is no coverage under a liability insurance policy covering property damage where the only allegation of property damage involved damage to the completed construction work (here the HVAC system) itself, requiring its removal and replacement. The Pennsylvania Supreme Court decision the court relied on clarified that the risk intended to be insured against is the possibility of damage to property other than to the completed work itself – yet another touchstone in coverage analysis.

The court distinguished a decision where the court found coverage for a claim arising from an “occurrence” because, among other reasons, the plaintiffs asserted faulty workmanship claims for bodily injury. In the newly reported decision, on the other hand, the claims arose from DTL’s alleged faulty workmanship and the “foreseeable consequences of that workmanship” – replacing the HVAC system. Another decision distinguished in the current case completes the picture of coverage by involving claims against an industrial fan designer and manufacturer, where a fan failed due to design defects. The court concluded that the claims were an “occurrence” within the meaning of the policy, because they involved a product that actively malfunctioned, which could give rise to an “accident.”

Cleaning up the “campsite,” State Farm also moved for summary judgment on 13 counterclaims asserted against the insurer by the Evanses after they settled with the contractor and HVAC subcontractor and received an assignment from DTL of its claims against State Farm. The court held that, because all of the counterclaims other than one alleging insurer “bad faith” against State Farm fell outside the scope of the assignment of DTL’s rights of action against State Farm.

Finally, since the only counterclaim the Evanses owned and have standing to pursue as the real party in interest, is the one for “bad faith,” and the court already found that State Farm had no duty to defend or indemnify DTL for its faulty workmanship. It follows that DTL had no viable claim for bad faith –in its hands or in those of the Evanses.

Another Appellate Court Holds that Faulty Work Constitutes an Occurrence – This Time Under New York Law

Eric M. Gold | Pillsbury Winthrop Shaw Pittman LLP | April 16, 2018

It is axiomatic that in order to obtain insurance coverage a policyholder must first establish that a claim falls within a policy’s insuring agreement before coverage under the policy is triggered.

For construction claims brought under CGL policies, that frequently means showing that the damages at issue constitute “property damage” caused by an “occurrence” (where “occurrence” is generally defined as “an accident”). While this requirement may often seem like a simple factual question, in the context of a subcontractor’s faulty workmanship, the analysis has proven more difficult. Where alleged faulty work causes damage only to the insured’s own work product, is the property damage accidental?

Over the years, courts across the country have been asked to make this determination, with varying results. The Tenth Circuit’s recent decision in Black & Veatch Corp. v. Aspen Insurance (UK) Ltd. adds another federal appellate court decision to the mix and continues a trend finding that faulty subcontractor work constitutes an “occurrence” under standard form CGL language. This case, handled by Pillsbury’s Insurance Recovery and Advisory Group and argued in the Tenth Circuit by Pillsbury Chair David Dekker, is notable because it addresses the issue under New York law—which is sometimes less favorable towards policyholders—and highlights the clear movement of jurisprudence on this issue in the direction of coverage.

In 2005, the insured entered into contracts “to engineer, procure, and construct several jet bubbling reactors (JBRs), which eliminate contaminants from the exhaust emitted by coal-fired power plants.” The insured subcontracted the engineering and construction of the internal components for at least seven of the JBRs, but deficiencies in the components procured and constructed by the subcontractors allegedly caused the internal components of the JBRs to deform, crack and sometimes collapse, in addition to other damages.

The standard form CGL policy at issue provided coverage for damages arising from an “occurrence,” which included an accident causing damage to the property of a third party. The policy also contained a “Your Work” exclusion, which barred coverage for property damage to the insured’s own work, and an exception to this exclusion, which preserved coverage for damage attributable to faulty work performed by subcontractors.

The primary question addressed by the Tenth Circuit panel was whether the New York Court of Appeals, the highest New York court, would hold that the policy’s insuring agreement covered the property damage to the JBRs. In a 2-1 decision, the Tenth Circuit found that coverage applied.

Relying on previous New York Court of Appeals decisions construing coverage under the same policy language, and the drafting history of these provisions in the CGL policy form, the Court held that the insured did not expect or intend its subcontractors to cause damage, so the damage was accidental. The Court also held that the damage to the JBRs constituted property damage to the owner of the plants, a third party. Rejecting the insurer’s arguments to the contrary, the majority held that any “interpretation of ‘occurrence’ as excluding the damages at issue here would render several Policy provisions meaningless, in violation of New York contract interpretation rules.”

Specifically, the Court found that the “Your Work” exclusion would be “redundant” if the definition of “occurrence” “categorically and preemptively precluded coverage” for damage to the insured general contractor’s own work in the first instance. The Court also held that there would be no reason for the policy to include the subcontractor exception if the basic insuring agreement did not provide coverage for damages to the insured’s work when the damaged work was performed by a subcontractor. To give these provisions meaning, the Court held that an “occurrence” must encompass damage to the insured general contractor’s own work arising from faulty subcontractor workmanship.

Importantly, the Court also emphasized that its decision followed a trend of state supreme court decisions considering this issue since 2012. These recent decisions reached “near unanimity” that construction defects can constitute an occurrence. The Tenth Circuit held that it expected the New York Court of Appeals to “join the clear trend among state supreme courts holding that damage from faulty subcontractor work constitutes an ‘occurrence’ under the policy.”

This case adds to the growing number of jurisdictions finding that a subcontractor’s faulty work constitutes an “occurrence” under standard form CGL language and provides additional authority to policyholders pushing their carriers to obtain coverage for a subcontractors’ faulty work.

CA Supreme Court Set to Rule on Important Occurrence Issue Certified by Ninth Circuit

William S. Bennett | Saxe Doernberger & Vita PC | March 9, 2018

The California Supreme Court recently heard oral arguments over whether an insurer is required to cover allegations that a builder negligently failed to supervise an employee who sexually assaulted a middle school student while working at the student’s school. The question was originally certified to the California Supreme Court by the Ninth Circuit in 2016, but nothing happened until the court heard arguments on March 6, 2018.

The case is Liberty Surplus Ins. Co. v. Ledesma & Meyer Construction Co., docket no. S236765.  Ledesma & Meyer Construction (“L&M”) contracted with the San Bernadino County School District to complete work on a middle school. Allegations arose that a project assistant, who is also a registered sex offender, molested a 13-year-old girl at the school. The victim prevailed on claims against L&M, including negligent hiring and supervision. L&M tendered the claim to Liberty, which denied the claim contending that there was no occurrence under the policy.

While the Ledesma & Meyer case addresses an important coverage question on its own, the court has indicated that it may have even broader consequences. Also before the California Supreme Court is the review of a California Appellate Court ruling that a pharmaceutical company’s misleading marketing of opioid painkillers, allegedly leading to the nation’s opioid epidemic, was intentional and, therefore, not an occurrence. Travelers Property Cas. Co. of America v. Actavis, Inc., docket no. S245867. The Supreme Court indicated that it will take up the appeal of the Appellate Court’s ruling but issued a hold on briefing in the case pending resolution of the Ledesma & Meyer matter.

The common thread between Ledesma & Meyer and Actavis appears to be the question of whether intentional conduct by a policyholder that leads to unintentional consequences constitutes an occurrence in a liability policy. This issue has broad consequences for any policyholder with the potential for a coverage dispute in California. SDV will monitor these cases and issue additional updates when the rulings are issued.